US dollar buoyed by higher yields, Asian currencies hit

July 8, 2013 — Mitul Kotecha

Efforts by the European Central Bank and Bank of England to disassociate themselves from Fed policy actions were overwhelmed by the US June jobs report which revealed a bigger than consensus 195k increase in payrolls and upward revisions to previous months. The data reinforced expectations that the Federal Reserve would begin tapering in September while the data also pushed US yields sharply higher (close to 23 basis points increase in US 10 year yields following the data) and fuelling further USD strength.

In fairness attempts by the ECB and BoE to introduce ‘forward guidance” may eventually garner some success but US yields will continue to dictate market direction, at least until the markets successfully transition to the reality of Fed tapering, which could take several weeks. During the interim expect transitional volatility to continue, with risk assets globally remaining under pressure.

Further detail on Fed policy will be looked for from within the minutes of the June FOMC meeting to be released on Wednesday although it is unlikely that there will be any real divergence from the message delivered by Fed Chairman Bernanke and a host of other Fed officials over recent weeks. Consequently the USD is likely to retain a broadly firm tone as it reacts to the sharp move higher in US yields at the end of last week.

The Bank of Japan will likely be emboldened in its ultra easy monetary policy stance following last week’s ECB and BoE announcements although no further policy action is likely at this week’s meeting as attention shifts to Japan’s Upper House elections on 21 July. The JPY in particular will remain susceptible to USD strength and widening yield differentials, with potential to test USD/JPY resistance around 102.45 this week.

European attention will centre on Greece and Portugal as the former will be the focus of discussions at the Eurogroup / Ecofin meetings today and tomorrow, with officials set to deliberate Greece’s bailout. Attempts in Portugal to resolve political differences between the main coalition parties appears to have garnered some success in a deal which could stave off fresh elections. None of this will help the EUR which is set to remain under pressure as it edges towards support levels at 1.2744 versus USD.

USD strength will also continue to be exhibited versus Asian currencies this week. Equity fund outflows continue to damage regional currencies lower. Since the end of May Asia has recorded around USD 15.4 billion in equity outflows. Total inflows this year have dropped to only around USD 3.6 billion. A renewed fall in the JPY will added pressure to more JPY sensitive currencies such as TWD and KRW but the overwhelming influence is higher US yields and capital outflows which will continue to have particularly negative impact on currencies with external funding needs, especially the INR and IDR.

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Australian dollar unworried by political developments

June 27, 2013 — Mitul Kotecha

The USD remains firm but is struggling to make further headway against major crosses. Some improvement in risk appetite, firmer equity markets and slightly lower yields today may limit the ability of the USD to extend its gains in the near term (as the USD usually suffers when risk appetite improves and US yields drop) although we expect any setback to prove temporary, with US Treasury bond yields set to continue to move higher over the coming weeks, albeit at a more gradual pace.

USD/JPY’s rebound has stalled over recent days despite the fact that US bond yields have continue to rise relative to Japanese JGB yields. My analysis of JPY performance during the last thee periods of sharply higher US yields shows that the JPY weakened versus USD in the first two periods and is on the verge of doing so in the third period (since early May).

Additionally the JPY has maintained a strongly negative correlation with US yields over the past 12 months. All of this suggests that the JPY will resume a weaker trend over coming weeks although markets may wait until the Japanese Upper House elections on July 21 and subsequent news of further reforms before pushing the JPY much weaker.

It if wasn’t enough that the AUD was suffering from higher US yields and China concerns, the announcement of a leadership election for the Labor leadership will have done little to bolster confidence in the currency. That said, politics is not an important driver of the AUD and the currency managed to eek out some gains despite Prime Minister Gillard’s loss in the contest.

Some easing in funding tensions among China’s banks has helped the AUD, with the currency showing encouraging signs of stabilization over recent days. However, its limited progress is still a long way from becoming a sustained rally. AUD/USD has a very negative correlation with 10 year US Treasury yields over the past 3 months, and continues to remain susceptible to further US yield increases until the market finally becomes accustomed the prospects of Fed tapering.

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“Feral hogs” beware

June 25, 2013 — Mitul Kotecha

Bond and equity selling has been sustained as worries both about Federal Reserve tapering and liquidity in China’s banking sector continues to roil markets. Fed comments overnight did little to soothe market angst, with the Fed’s Fisher and Kocherlakota both revealing little concern about the market reaction to prospects of Fed tapering. However, both Fed officials were keen to point out that policy will remain accommodative even after the end of quantitative easing which helped to allay some of the pain on markets in overnight trading.

Reinforcing market volatility is the approach of month and quarter end. Several other Fed speakers will be on tap over coming days while 2, 5 and 7 year Treasury auctions will also be under scrutiny but ahead of the speeches and auctions markets will look to today’s US data releases including May durable goods orders, June consumer confidence and May new home sales for further direction.

EUR/USD failed to get much of lift from the rise in the German IFO business confidence survey in June and looks set to extend declines over coming sessions. Despite its drop from its high around 1.3420 EUR/USD has not been particularly sensitive to higher US yields over recent weeks but this may be changing. As revealed in the latest CFTC IMM report net speculative positioning in EUR/USD became positive for the first time in four months.

Now that the room for EUR short covering has disappeared EUR’s sensitivity to yield is likely to grow. The fact that the 10 year US Treasury yield differential with bunds has widened sharply will be difficult for EUR/USD to ignore, with attendant negative consequences for the currency. The lack of key Eurozone data releases over coming days will leave the EUR/USD increasingly at the mercy of US yield movements.

Another currency having to deal with a relatively thin data slate is GBP. Only the government’s Spending Review, Bank of England Financial Stability Report and second estimate of Q1 GDP are scheduled for release this week but none of these are likely to prove to be market movers. Having been hit by a firmer USD, GBP/USD has fallen well off its recent highs around 1.5752. On the crosses GBP looks a little healthier but is notably failing to make any headway against the EUR.

While the USD has rallied on higher US yields markets are not looking for a similar policy moves in the UK, especially given that some BoE MPC members are still inclined to increase asset purchases. Indeed, the recent rise in UK gilt yields may embolden the doves on the MPC. Although net speculative short GBP positions have not fully evaporated, the room for GBP upside is now very limited, with a firm USD in general set to continue to push GBP lower.

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US dollar running rampant

June 24, 2013 — Mitul Kotecha

A calmer tone looks like it will settle over markets today after recent sharp volatility. However, little relief to the pain inflicted on markets from tapering fears is likely this week. Weaker growth and funding concerns in China added another layer of uncertainty to the market psyche although comments from China’s central bank the PBoC about “fine tuning” may help to allay fears of a wider credit crunch.

Meanwhile across the pond Fed officials are probably quite frustrated by the market reaction to last week’s FOMC statement. There will be plenty of Fed speakers on tap this week to provide clarification, with markets looking for some soothing comments. Given the varying and diverse views among Fed officials such hopes may be dashed.

Data releases both in the US and Europe will be encouraging in terms of recovery expectations but will do little to ease the angst over tapering. In the US durable goods orders and new homes sales will record gains in May while June consumer sentiment indices will remain at relatively high levels.

In Europe, aside from the European council meeting this week the German IFO business confidence survey today and economic sentiment gauges later in the week are set to rise in June. In Japan the main CPI inflation gauge will stabilize in May although reaching the 2% inflation targets remains as difficult as ever while industrial production is set to decline in May due to still fragile foreign demand.

Most asset markets will continue to track bonds, with equities, and commodities remaining under pressure and the USD supported by higher US yields. Notably 10 year Treasury yields spiked to over 2.5%, a sharp increase over the week. Consequently the USD’s firm tone was expressed across a broad swathe of currencies, with Scandinavian, Latam and commodity currencies among the worst performers.

Emerging market and commodity currencies are set to suffer from continued capital outflows while the USD runs rampant. However, many currencies look oversold and over the near term some stabilisation is likely as they benefit from a slightly better risk tone at the turn of the week. As indicated by the latest CTFC IMM data, the USD long positioning has been cut back, suggesting scope for further gains. EUR positioning has turned net long for the first time in four months implying no further room for short covering.

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Bracing for a world without steroids

June 21, 2013 — Mitul Kotecha

The sell off of risk assets in the wake of the Fed’s surprisingly direct FOMC communication continues unabated. Hopes that Fed chief Bernanke would attempt to assuage market concerns about tapering have been blown apart and instead the reality of forthcoming tapering continues to bite leading to higher US yields, weaker stocks and commodities and a firmer USD. In fact the USD appears to have finally re-established its positive relationship with yields and risk aversion.

The situation hasn’t been helped by the fact that data out of China has disappointed while local money market rates had risen sharply this week. Separately Japan’s reform momentum appears to have stalled ahead of Upper House elections as Prime Minister Abe’s third arrow missed target.

In combination these factors mean that markets are bracing for the day that they no longer have steroid injections to keep them going. Instead fundamentals will become important to sustain gains in risk assets. Why should anyone be surprised? US growth is recovering and at some point tapering has to occur. Unfortunately risk assets were just not ready for this revelation.

Ongoing volatility and uncertainty is likely to persist over the coming weeks as markets transition to an environment of Fed tapering, but this will give way to a renewed improvement in risk appetite and lower volatility later in the year.

The USD index continued to rise overnight having corrected around a third of its losses since 22 May. Gains remain broad based with gains registered against major and emerging market currencies. US Treasury yield differentials with other countries continue to widen across the board leaving the USD in strong form (10 year Treasury yield has risen by close to 80 basis points since early May).

Going forward firmer US data, taken together with higher US yields, will continue to drive the USD higher against major currencies, while some improvement in risk appetite as investors become accustomed to the prospects of Fed tapering will allow emerging market currencies to recover some, but not all lost ground against the USD.

Many currencies have become highly sensitive to US yields, with the TRY, NZD and INR the most sensitive over the past three months although notably most Asian currencies are near the top in terms of sensitivities.

Against this background unsurprisingly Asia continues to register capital outflows. All Asian countries have registered capital outflows this month, with total equity outflows of $10.2 billion registered, led by South Korea and Taiwan. Obviously the bigger concern is for deficit countries including India and Indonesia, with their currencies remaining particularly vulnerable to capital outflows.

Recent market volatility has meant that the prospects of Japanese investors stepping up their outflows have diminished over the near term. The latest data released yesterday showed that Japanese investors repatriated capital for a fifth straight week.

It is only a matter of time before outflows pick up as risk appetite improves as US yields move higher. The US 10Y Treasury yield advantage has widened versus Japanese JGBs to around 153bp and I expect this to widen further to around 185bp by the end of 2013. This will be consistent with a renewed slide in the JPY versus USD.

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